4 common mistakes in selling stocks

Morningstar recently produced a report entitled “4 common portfolio mistakes”. The common denominator is just when investors should be monitoring the fundamental outlook for stocks they own, they are instead focusing on historical share price movements.

This may be the result of various cognitive biases. One of these is anchoring, which describes the common human tendency to rely too heavily on the first piece of information offered (the anchor) when making decisions. The four common investing mistakes were to sell a stock because it has done too well, sell because it has done badly, not selling because it has gone badly or not selling a stock because “it has always done well in the past”.

In a classic anchoring example, I remember discussing Telstra (ASX: TLS) with various stockbrokers when it was approaching its nadir below $3. There is a tendency for even advisors to revert to old biases and at the time, clients of brokers had suffered significant losses by owning Telstra. The papers were also reporting on the Future Fund selling down its significant holding. In short, advisors and investors had reached their pain threshold and were now selling because it had done badly.

However, the reality had become separated from an unemotional assessment of the company’s prospects. Telstra was about to receive guaranteed payments from the government (thereby becoming a pseudo bond) at a time when bonds were rallying hard. Additionally, it was trading on a 14% dividend yield while interest rates were plummeting, making it a comparatively attractive investment.

Macquarie Group (ASX: MQG) is an example of a stock that had become grossly overvalued at near $100, prior to the global financial crisis. Then changing market conditions affected the company. Questions arose over its business model, negligible merger and acquisition work and a dearth of initial public offerings. Like Icarus, it subsequently fell back to earth to trade below $20. Some investors at the time of its peak would not have contemplated selling, because in their memory “it had always done well in the past”.

Foolish takeaway

Whether to continue holding a stock is just as important as whether to buy in the first place. While investors should resist anchoring, they don’t need to be physically anchored to their desks to continually reassess the fundamental company outlook. Morningstar propose a “two pronged monitor and investigate approach”. This involves broadly monitoring stocks in your portfolio and every 6 to 12 months doing a more thorough assessment.

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Motley Fool contributor Mark Woodruff owns shares in Telstra.

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